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DAVID KRUSE

By Staff | Mar 25, 2011

The first knee-jerk reaction to the disaster in Japan was to get liquid. There is a physical need for money in Japan and one way to get it is to sell something to raise cash.

Fund managers sucked into the moment sought liquidity as a solution to avoid the undefined risk.

As a general statement fund investment in commodities is not smart money. They are in a sector that they are generally unfamiliar and even uncomfortable with. They do not have a depth of understanding of commodity fundamentals nor do they have any depth to their bench of institutional advisors who often have enough experience with commodities to be dangerous.

The Japanese brokerage company Nomura liquidated its commodity division after poor performance. We actually need this investment money to capitalize the expansion of global food production capacity, but right now they are grappling with the concepts like porcupines, which are not sure that they like each other, trying to make love.

I believe that investment funds are behind the curve of understanding commodity fundamentals and that we have to compensate for their rookie inexperience in the ag sector.

While the need to initially acquire liquidity was bearish, everything else happening in Japan is bullish to ag commodities. The more that their food supply is contaminated by the nuclear accident, the larger the imports of safe food they will have to buy and import.

Their port infrastructure was damaged causing delays in offloading of ships, but nothing had been diverted yet so they were expecting problems to be resolved.

They will fix their food supply chain first. There may be a brief reduction in grain/feed/meat imports related to the damage, but it will be corrected relatively quickly. Some farmland may be rendered useless and some livestock may be destroyed in response to the threat of fallout contamination.

If this disaster disrupts investment moving into capitalizing the ag sector capacity expansion, it is bullish. Central banks are going to be more accommodative than they would have been as a result of the disaster. They will not tighten monetary policy as quickly as they would have otherwise.

The bond market is climbing bringing interest rates down again. There is now something tangible to blame price increases upon other than their old scapegoat – ethanol.

The idea that a slow down in the Japanese economy will somehow derail world economic growth is inaccurate. MERC economists pointed out that the IMF only forecast 3 percent of world GDP growth coming from Japan this year. The share of GDP growth coming from China was forecast at 9 times that of Japan.

Japan is not going to derail a U.S. economic recovery either as it only accounts for 4.7 percent of U.S. exports. Those exports are weighted to Ag commodities which may actually be good for the U.S. as they are less likely to suffer long.

What has occurred is not enough to alter the tight supply demand balance sheet. It creates another break to buy that I believe has a high chance of being fully recovered later in the year. Farmers had quit selling on recent strength.

My intellect was questioned when we made some sales near the highs. We could make those sales and cover them back up with call spreads and profit from a market recovery. The best way to get farmers to make sales is to break the market sharply cooling the bullish psychology and then rally it back which motivates sales.

I think that the markets have a lot of work to do yet. I don’t think that they have sorted out physical supply and that in order to end with USDA carryouts projected, demand has to be cut. Who stopped using corn? No sector that I know of, and livestock and ethanol margins improved significantly this month. Corn prices fell more than ethanol prices did. Chinese grain/soy prices have not fallen as much as U.S. prices.

Fixing their food supply chain will be high priority for Japan. Fixing broken infrastructure will boost demand for all commodities. With the recent Mideast turmoil, roiling oil prices and the need to sustain the money supply in Japan, central banks the world over will be hesitant to tighten monetary policy.

The market break put doubt into producers raising the risk in expanding future production. It sent the wrong market signals to both producers and endusers about tight stocks that if they respond to them, could produce an even greater clash between supply and demand of epic proportions.

We expect a lot of cotton, more corn and fewer soybean acres in the planting intentions report, but not enough acres of corn and soybeans to buffer weather risk, which is shaping up to be greater than normal this year.

The La Nina is not going to do more than neutralize which would mean an average crop and if it doesn’t neutralize we may have a real problem supplying demand.

We expected a 40-week cycle low in corn prices to occur in March. The exhaustion tail from selling at this week’s low should be the low of the cycle and bull markets should turn back on. Hope that you got some risk management done.

David Kruse is president of CommStock Investments Inc., author and producer of The CommStock Report, an ag commentary and market analysis available daily by radio and by subscription on DTN/FarmDayta and the Internet.

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